The monetary safety net

Timely insights from portfolio managers and industry experts on key financial, economic and political issues.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.

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      By Jeffrey D. MuellerCo-Director of High Yield Bonds, Portfolio Manager, Eaton Vance Advisers International Ltd. and Justin H. Bourgette, CFAPortfolio Manager, Global Income Team

      London - As credit-markets investors, we focus on fundamentals and valuations as the key drivers of long-term returns in the core markets of high-yield corporate bonds and floating-rate loans. An area that we are paying closer attention to right now, however, is the monetary policy of major central banks, which we expect may be a key driver of credit market developments in the short term.

      Keeping the reins loose

      Monetary policy continues to be supportive of growth. In the left-hand chart below, we see that the balance sheets of global central banks hit an inflection point late last year, with year-on-year changes in absolute holdings tipping from negative back into positive territory. The reversal reflects a move by the US Federal Reserve (Fed) and European Central Bank to re-start asset purchase programmes in the second half of 2019.

      We can observe the effect of the balance sheet expansion in the chart on the right-hand side, which shows the growth rate for the global money supply, an important indicator of future spending tracked by economists and policy-makers alike. After bottoming out in late 2018, global money supply growth is rebounding strongly. The Fed's decision to keep rates unchanged at its 29 January policy meeting should support this further, in our view, as we do not believe that the full impact of the Fed's three earlier rate cuts in 2019 has yet to be felt completely.

      Central bank balance sheets and global money supply

      Blog_image_30 1 2020

      Source: Macrobond as of December 31, 2019. Data provided is for informational use only. Central bank balance sheets measures Federal Reserve, European Central Bank, Bank of Japan and People's Bank of China. M2 measures money supply as it includes the most liquid portions of the money supply, including currency and assets quickly converted to cash as well as several less-liquid assets.

      Demand up, defaults down?

      Conventional economic thinking suggests that an increase in the supply of money is likely to precede an increase in consumer spending, investment by firms and an overall boost in aggregate demand. And an upturn in global demand should be a boon for companies. As such, we do not expect to see a worsening in credit quality in the short term. Notably, default rates for high-yield bonds and floating-rate loans are already low by historical standards at the 3% level, while distress ratios for both high yield and loans are modest and falling.

      Bottom Line: Continued easy monetary policy from central banks is increasing liquidity in the financial system and fuelling an increase in the global money supply. While we recognise we are in the latter stages of this credit cycle, the trends apparent in the charts above represent two key reasons why we believe the next spike in default rates is far from imminent across the core credit markets of high-yield corporate bonds and floating-rate loans.